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Long-Term Contracts Make Pipelines Attractive Income Investments

Pipeline operators earn a steady flow of cash from the long-term contracts that they have with oil and gas companies to provide transit services for their resources. This allows these companies to steadily grow their distributions as they acquire new pipelines, which also carry such contracts.

One of the most important things to consider when buying a dividend stock is the sustainability of the company's dividend. An investor must make sure that the company is generating enough cash flow to pay its dividend and needs to be able to continue generating its current level of cash flow lest the company be forced to cut its dividend. One of the nicest situations is when the company's customers have promised to continue paying the company over a long period of time. This is one reason why pipeline companies such as Kinder MorganEnergy Partners(UNKNOWN:KMP.DL) or Pembina Pipeline(NYSE:PBA) tend to make good income-producing investments.

Positive effectsWe can see the advantages of this business model by looking at the earnings reports of several of the major pipeline companies. Kinder Morgan Energy Partners is by far the largest pipeline operator so it makes sense to start there.

Kinder Morgan Energy Partners announced its first quarter results on April 16, and they were quite good. Kinder Morgan Energy Partners was able to successfully increase the distribution that it pays to investors by 6% year over year. This was the 51st such increase since the company's current management took over the company in February 1997. This increase was made possible due to the company's growing distributable cash flow. Kinder Morgan Energy Partners had total distributable cash flow of $693 million in the first quarter of 2014. This represents a 26% increase over the $550 million that it had in the prior year quarter.

This strong and consistent growth record speaks volumes to the strength of Kinder Morgan Energy Partners' business model. Of course, this growth is largely driven by the company's near-continuous acquisitions of new pipelines. Thus, the growth is not entirely due to the pipeline business but due to acquisitions. The pipelines merely produce steady and consistent cash flows over the long term.

Another exampleWe can see further evidence of this by looking at the earnings report from another pipeline company, Enterprise Products Partners(NYSE:EPD). Enterprise Products Partners is also one of the largest pipeline companies in the United States, and so it should also serve as a good demonstration of the value of the industry's long-term contracts.

Enterprise Products Partners reported its first quarter results back in May and, like Kinder Morgan, the company showed fairly strong year-over-year growth, although it was nowhere near as strong as Kinder Morgan's. In the first quarter of 2014, Enterprise Products Partners had total revenues of $12.9 billion. This represents an increase over the $11.4 billion that the company earned during the first quarter of last year. This higher revenue managed to make its way down to the company's cash flow, with Enterprise Products Partners generating free cash flow of $704.4 million in the first quarter of 2014 compared to $367.4 million in the first quarter of last year. This is the sort of thing that we like to see because a growing free cash flow means that more money is available to the shareholders than in the prior year period.

What does it all mean?The impact of these growing cash flows and thus the strength of the companies' business models can be seen by looking at each company's distributions. Both Kinder Morgan Energy Partners and Enterprise Products Partners boast respectable distribution yields, with the former company yielding 6.99% and the latter yielding 3.78%. But, what is more important is each company's distribution history, as each has a history of consistently increasing its distributions. For example, here is Enterprise Products Partners' distribution history:

Source: Enterprise Products Partners

And here is Kinder Morgan Energy Partners' distribution history:

Source: Kinder Morgan Energy Partners

The fact that these companies have been able to grow their distributions over time is a testament to the strength of their business models. Thus, they should be able to continue to grow these distributions going forward. This will allow investors in these companies to generate a consistently growing stream of revenue from them.

Daniel Gibbs has a long position in Pembina Pipeline. His research firm, Powerhedge LLC, has a business relationship with a registered investment advisor whose clients may have positions in any stocks mentioned. Powerhedge LLC has no positions in any stocks mentioned and is not a registered investment advisor. The Motley Fool recommends Enterprise Products Partners. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.